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Retail's Risk and Reward Strategy in Credit Services for Consumers

Before major credit cards even existed, there were store financing accounts. The benefits for the retailer were two-fold; they gave consumers greater buying power and generated additional revenue through finance charges and fees.

For some major retailers today, the business of a private label credit card has grown to become a sizable percentage of revenue. For example, last year the jewelry chain Zales (ZLC) reported that 40 percent of its U.S. revenue was from its store card. The card from Target (TGT) brought in $351 million in revenue for the company, and that was just during the fourth quarter alone.

With so much money being made, then why on earth are many store cards in danger of going extinct?

Reason #1: The Credit Card ACT of 2009

The CARD Act greatly restricts how fees and interest rates can be levied on a customer’s account. Prior to the reform, store cards were making a killing on late fees, APR hikes, and the like. Even more so than major credit cards, because store accounts tend to attract customers who are less creditworthy, and hence, more likely to mess-up.

Previously, the fees and penalty APRs of nearly 30 percent generated more than enough revenue to outweigh the overhead. However now with the reform in full effect, that doesn’t always hold true. Especially with small chains, who may only have a cardholder base in the tens of thousands. For major retailers like Target or Kohl’s (KSS), the model can still work under the right circumstances given their economies of scale, but for small chains it’s a struggle.

Reason #2: Bleeding Bad Debt

In a perfect world where everyone pays their bills, store credit cards would still be a wildly profitable venture regardless of how small or large the company may be.

Of course, we don’t live in a perfect world and as you would expect, during the past few years defaults have skyrocketed on these types of cards. This throws another wrench into the works, as now they’re not only facing lower fee income, but also higher default rates.

Reason #3: Reward Programs

Many store credit card offers don’t even have rewards, but for the ones that do, obviously it’s not cheap to chuck back 3-5 percent to the customer. If the cardholder is carrying a balance than the finance charges will offset the rewards. However, consumer behavior has changed since the recession – fewer customers carry balances. That, compounded with the CARD Act, means it’s become more costly to run these reward programs.

Last fall Citi axed the ConocoPhillips (COP) co-branded MasterCard (MA) and in January of this year, they did the same to the CITGO MasterCard. An unnamed credit card executive with one major oil company was cited here as saying the reason for this is because the rewards are unprofitable, compared to the costs of marketing the cards.

For Citi and other big banks that issue co-branded Visa/MasterCards, they’re essentially competing against themselves. On one hand, they can issue a branded MasterCard and split the profits with the gas station. Or they can issue their own in-house gas credit cards which are not affiliated with any station and keep the money for themselves. When you look at it that way, is it any wonder why they’re being cancelled?

What will the future of store cards look like?

During the past 24-36 months, the selection of niche store cards has thinned out dramatically. Don’t be surprised if this trend continues given the current economic environment. Also as oil prices rise, more co-branded gas credit cards will likely disappear.

There is still a silver lining in this for the largest retailers who have the resources to run a credit card program in-house. Take Target as an example. During the recession their co-branded Visa (V) card was terminated, but a new store-only 5 percent rebate card was launched. It has been a smash hit and since Target runs the operation internally, they’re the ones reaping the profits from it.

Ultimately what it boils down to for the store is the act of balancing lower fee revenue, with higher expenses… and somehow coming out ahead. The little guys won’t always be able to do it, but for the largest retailers it still remains a viable revenue stream when properly executed.

By Michael Dolen, editor-in-chief of CreditCardForum, a source for the best credit card offers organized by category, ranging from cash back to balance transfers and everything in-between.

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